How weird would it be if paper plates were more expensive than phones?
This could only happen in some alternate universe devoid of trees, but it is interesting to think about what drives value in this sense. Why are iPhones more expensive than dining ware? Someone must have tried for a while to sell paper plates for $20 a pop only to fold after being mocked repeatedly.
Anyone who has sat in an economics class probably understands that supply and demand determine the prices of goods. The fewer widgets there are, or the more people who want one, the higher the prices. Yada yada, and then the class starts napping. But anyone who has stayed awake in an economics class has probably heard of price elasticity, which has just as large an impact on retailers’ decisions. If you took notes in lecture then you won’t need this quick refresher course on price elasticity, but there a few things those who were sleeping should know.
In its simplest form, price elasticity measures the effects small changes in prices have on the demand for that product. Easy enough, but as a retailer you really care about how price sensitive customers will be to the goods you sell.
For the mathematicians out there, there are plenty of opportunities to A/B test the prices of products, collect massive amounts of data, and run some regressions to figure out the exact elasticity. That is certainly the precise way to do it, but there are a few good rules of thumb to consider when figuring out consumers’ price sensitivities.
Availability of Substitutes
If a given product has plenty of substitutes, chances are that the consumer will be much more sensitive to the price than if the product’s value was unreplicable. Consider someone interested in buying pencils. Like a true American, Ticonderoga is the usual choice, but its price has been raised from $1 to $2 due to deforestation worries. Some diehard fans may still pay the $2 per pencil, but the majority of customers will turn to a substitute that remains cheaper, such as pens, highlighters, or mechanical pencils.
Price changes in a different good can also affect demand for your good. Think about how Amazon handled the Kindle, and the subsequent explosion of demand for eBooks. By lowering the price of e-readers, Amazon greatly increased the demand for eBooks, just as $1/gallon gas would prompt many people to go out and buy a car. When the prices of goods complementary to those you’re selling change, demand for your goods will change proportionally.
Timeframe to Make a Decision
The longer a price change sticks, the more sensitive to the price change consumers will be. This intuitively makes good sense. Let’s say midway through your kid’s hockey season, prices of hockey gear suddenly jumps up 50%. If your kid’s stick breaks, you will still need to buy a new stick or receive a few strange looks when your kid takes the ice with a baseball bat. In the short term, you suck it up and shell out the extra money. But if hockey gear prices remain at that level next winter, you may encourage your kid to try basketball. Retailers operating on a subscription model should think about this. While most people could deal with paying more for just one month (granted valid reasoning), raising prices over the long term will inevitably lose customers.
Household Budget Allocation
If a good takes up a larger portion of a budget, a customer will undoubtedly be more sensitive to price changes. For those of us unable to dive into a pool of gold coins, buying a car is a very thought-out purchase that many will spend months researching. Seeing a car 10% more expensive than another will raise questions as to what features make that car worth the extra money. Those same people will then not think twice about why a can of soda is suddenly a dime more expensive; they are thirsty and soda is a common expense so they will buy that can for $1.10 in a heartbeat. So keep in mind how your products fit with your consumer’s budget before fiddling with prices.
These examples are only a small sample, as many other small factors can influence a customer’s price sensitivity. Any good ones come to mind? Let us know in the comments!
Contributing Writer: Jack Symington